The arrest announced Monday of Charlie Shrem, a New York-based bitcoin entrepreneur for alleged links to illegal drugs exchange Silk Road, brought bitcoin squarely back into association with activities — drug purchases, money-laundering — that its more mainstream advocates have sought to downplay.

The cryptocurrency has emerged as a darling of venture capitalists, championed by both young entrepreneurs and Internet legends like Marc Andreeson, who are eager to establish the digital currency as the next frontier for financial payments. But law enforcement has shown it’s ready to act if –in officials’ words — bitcoin is used for very “old-fashioned” crimes.

“Truly innovative business models don’t need to resort to old-fashioned law-breaking, and when Bitcoins, like any traditional currency, are laundered and used to fuel criminal activity, law enforcement has no choice but to act,” said U.S. attorney Preet Bharara in a statement.

Shrem, the chief executive of the bitcoin company BitInstant and vice chairman of the Bitcoin Foundation, was arrested Sunday at John F. Kennedy International Airport. The Justice Department also unveiled the arrest of Robert M. Faiella, an underground bitcoin exchanger known as “BTCKing.”

Charlie Shrem

The two were allegedly involved in a scheme to sell more than $1 million in bitcoin to users of the bitcoin-only drug market Silk Road, which was seized by authorities in October. Charges include conspiring to commit money laundering and operating an unlicensed money transmitting business. Shrem, 24, was additionally charged with violating the Bank Secrecy Act, as he allegedly failed to report suspicious activity regarding Faiella’s illegal transactions through his company. The complaint doesn’t list BitInstant by name.

“We are surprised and shocked by the news today. As a foundation, we take these allegations seriously and do not condone illegal activity,” said a spokesperson for the Bitcoin Foundation in an email.

Shrem’s arrest illustrates a tug-of-war between the old and new proponents of bitcoin. Bitcoin is a virtual currency that its proponents have also described as a way to revolutionize payments. The concept was first circulated on a mailing list in 2008. In its early years, bitcoin was often associated activities such as buying banned drugs on the Internet through the website Silk Road. But interest in bitcoin, along with its price, surged in 2013 as bitcoin companies attracted funds from prominent investors, some of whom were involved in early Internet companies. The Senate held its first hearing on bitcoin and other virtual currencies in November that was described as pretty positive for bitcoin, propelling prices above $1,000 in the wake of the event.

The virtual currency isn’t created by a central bank, but instead relies on a process called mining that pits computers against each other in a race to solve cryptographic problems. The correct winners — computers often band together to mine as a group — are awarded a block of bitcoin. The first block of bitcoin was mined in January 2009.

Shrem co-founded BitInstant in 2011 with a $10,000 investment from his mother. Since then, BitInstant raised $1.5 million in a seed round led by Cameron and Tyler Winklevoss in May 2013. Shrem is also the co-owner of the New York City bar EVR, which accepts bitcoins.

Cameron and Tyler Winklevoss issued a statement in the wake of the arrest:

“When we invested in BitInstant in the fall of 2012, its management made a commitment to us that they would abideby all applicable laws – including money laundering laws – and we expected nothing less. Although BitInstant is not named in today’s indictment of Charlie Shrem, we are obviously deeply concerned about his arrest. We were passive investors in BitInstant and will do everything we can to help law enforcement officials. We fully support any and all governmental efforts to ensure that money laundering requirements are enforced, and look forward to clearer regulation being implemented on the purchase and sale of bitcoins.”

The Winklevoss twins and other major players in the bitcoin space are expected to speak at a few bitcoin events this week, including a two-day hearing run by the New York State Department for Financial Services that begins tomorrow.

Story Conversation

About The Tell

The Tell is MarketWatch’s fast and engaging look at trends and themes in the day’s markets. Drawing on our reporters, analysts and commentators around the world, as well as selecting the best of the rest online, The Tell is all about the pulse of the markets through news, insight and strategic information to help you make the best investing decisions. Got a tip? Tell us at TheTell@MarketWatch.com